European Bank in Strong Move to Loosen Credit

Mario Draghi, the central bank's president, second from left, had resisted calls to stand directly behind debtor governments by buying their bonds as necessary, without limit.Credit
Yves Herman/Reuters

After long resisting the kind of financial force Washington used at the height of the financial crisis in 2008, European central bankers on Wednesday pumped nearly $640 billion into the Continent’s banking system. The move raised hopes that the money could alleviate the region’s credit squeeze.

Though it is too soon to gauge any longer-term benefits, the move, by the European Central Bank, could be a turning point in the Continent’s debt crisis — a cascading problem that for nearly two years has plagued financial markets around the world and now threatens global economic growth.

American officials and global economists have long urged the Europe’s central bank to take just such an aggressive stance — even as European political leaders have repeatedly failed to devise concrete near-term plans to address Europe’s debt problems and deteriorating finances.

Carl B. Weinberg, chief economist at the consulting firm High Frequency Economics and a professed bear on the European outlook, said he was stunned by the size of the monetary operation, saying it suggested that Europe’s central bank had “shown a path toward averting catastrophic collapse in Europe.”

Indeed, some analysts suggest the central bank’s new lending program represents a kind of back door to the easy-money policy pursued by the Federal Reserve after the collapse of Lehman Brothers in 2008, which is widely credited with averting a broader economic disaster.

The three-year loans the central bank made Wednesday come with a bargain-basement interest rate of 1 percent, providing the region’s financial institutions with the kind of cheap financing they can no longer get from the market. Among other requirements, Europe’s banks need the money to refinance about a trillion dollars in loans that mature in 2012. Wednesday’s infusion could also help reduce the pressure on beleaguered government borrowers on the periphery of the Continent, most significantly Italy and Spain. Those countries have not been able to directly tap European Central Bank funds, even as investors are increasingly reluctant to finance those countries’ debt by buying their bonds.

Now, though, by lending to commercial banks at such low rates for three years, the central bank might induce them to use some of the newly available money to buy shorter-term government bonds, which have higher yields, or interest rates. Spain’s two-year government bond, for example, is currently yielding 3.64 percent.

Mario Draghi, the central bank’s new president, has resisted calls to stand directly behind debtor governments by buying their bonds as necessary, without limit. But the volume of money pumped into the system on Wednesday suggested that Mr. Draghi was prepared to indirectly support those governments through their nation’s commercial banks.

“This is exactly what happened in the United States with the Fed in 2008,” said Mr. Weinberg, the economist. By buying up bad loans and other impaired assets, and lending money to the banks, government officials in the United States were able to buy time for American banks to strengthen their depleted balance sheets.

But in the current case, European officials confront an even trickier situation. Not only must the banks borrow, but indebted European governments have huge borrowing needs of their own, totaling 1.1 trillion euros ($1.4 trillion) in 2012.

Despite those twin threats, German political leaders have opposed any outright bailout either for the banking system or for troubled government borrowers like Italy and Spain, whose free-spending ways have long irked voters in Germany, Europe’s largest economy and a principal financier of any bailouts.

If it works, the quiet virtue of the European Central Bank’s new lending program will be that it helped buttress banks while easing the pressure on governments — without the appearance of a direct rescue.

Although the program did not take effect until this week, it was announced on Dec. 8 as part of a broader series of European Central Bank efforts to stabilize anxious credit markets. The central bank said it would offer three-year loans — rather than the one-year limit it had previously imposed — and would accept a wider variety of financial assets as collateral, to make it easier for banks to qualify for the loans.

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The central bank is accepting the banks’ outstanding loans as security, a measure meant to help smaller community banks that might lack conventional forms of collateral like bonds.

“In many ways, it was a success,” said Nicolas Véron, a senior fellow at Bruegel, a research organization in Brussels. “But it exposes the E.C.B. to risks linked to the banks because no one knows the quality of the collateral they are providing.”

Until Wednesday’s announcement, it was not known how many banks would apply for the new loans or how much they would borrow.

In the end, 523 banks tapped the new program, borrowing 489.2 billion euros, well above the 300 billion euro estimate that market experts had been predicting. Though some of that money includes funds earmarked to replace existing loans, economists estimate that Wednesday’s action could inject 190 billion to 270 billion euros, as much as $353 billion, of new money into the European financial system.

The large number of banks that participated is also an indicator that the program has avoided the kind of welfare stigma attached to other types of rescue packages. Because the central bank does not reveal the borrowers’ identities, it is not known exactly which banks participated. But Italian banks including UniCredit and Intesa Sanpaolo borrowed a significant amount, a total of 116 billion euros among them, according to Reuters.

“This is as good as it gets for the banks,” said Gilles Moec, co-head of economic research for Deutsche Bank. “It’s a big deal.”

He said one crucial test of whether the new approach could address the bigger challenge of easing borrowing conditions for governments would come in February, when Italy has 46 billion euros worth of debt coming due. That same month, the European Central Bank plans to offer banks another round of three-year loans.

Mr. Draghi, despite his earlier opposition to channeling the central bank’s loans into government coffers, acknowledged in a speech Monday to the European Parliament that commercial banks might end up doing just that with their new, cheap money. “We don’t know how many government bonds they are going to buy,” he said.

Strong demand at recent Spanish debt auctions have driven down yields, suggesting that banks were loading up on the debt to use as collateral for the central bank loans, analysts said. But there are limits to their appetites for governments’ debt at a time when the banks are trying to reduce their vulnerability to a potential debt default by a big country like Italy, while also protecting themselves against the possibility of a breakup of the euro currency union if the 17 member nation’s cannot resolve the crisis.

Pumping new money into an economy is often seen as a textbook ingredient for inflation, if it leads to easy credit for businesses and consumers and a resultant spending spree. But that prospect is widely considered unlikely, at least initially, because Europe appears headed for an economic downturn. A weak economy will discourage much private borrowing.

Mr. Moec said the risk of higher inflation was minimal because “that would require that the banks were actually making loans to the private sector, and we think that’s going to take a while.”

Jack Ewing contributed reporting from Frankfurt.

A version of this article appears in print on December 22, 2011, on Page A1 of the New York edition with the headline: European Bank In Strong Move To Loosen Credit. Order Reprints|Today's Paper|Subscribe